Record iPhone sales and reduced margins dominate Apple’s third quarter

The company's revenues were flat, but reduced margins cut into its profits.

Apple dropped its financial results for the third quarter of fiscal 2013 today, and the news was decidedly mixed. Apple reported a quarterly record for iPhone sales (31.2 million, up from 26 million iPhones for the year-ago quarter), but iPad, iPod, and Mac sales were down slightly, and profits were down despite flat revenues from the same quarter last year.

Apple reported $6.9 billion in profit from $35.3 billion in revenue. The revenue was near the top of Apple's guidance for the quarter, but Apple's margins are down significantly.

The dip in profits can be tied directly to lower profit margins on Apple's products—gross margins fell between 36 and 37 percent this quarter, down around six percentage points from 42.8 percent margins a year ago. According to Apple CFO Peter Oppenheimer and CEO Tim Cook, the dip in margins is due in part to strong sales for the iPhone 4 and iPhone 4S, which have lower margins than the high-end iPhone 5. While Apple's latest flagship continues to sell well, aggressive pricing on the iPhone 4 in emerging markets made the older phone a larger part of Apple's product mix than the iPhone 3GS was in last year's lineup.

This, incidentally, makes a decent case for a lower-cost iPhone that sells for about the same price as the current iPhone 4 but is built to have higher margins than the aging aluminum-and-glass phone. Note that I don't mean a "cheap" iPhone aimed directly at prepaid customers, but a new product built to Apple's hardware quality standards that's purpose-built for customers currently served by the older flagships. During the analyst question and answer session, more than one analyst attempted to draw information from Cook and Oppenheimer about a lower-cost iPhone (as well as other teased "new product categories"), but neither would share any new information. The new Mac Pro was said to be coming "later this year" and both iOS 7 and OS X 10.9 were teased for "this fall," all information that we've had since WWDC. Apple refused to comment on release dates for either all-new products or new products in existing lines except to say that releases would begin in the fall and run through 2014.

Apple's other major product lines were all down in unit sales compared to a year ago. The drop in Macs was relatively small—Apple sold 3.8 million Macs in the quarter, compared to four million a year ago. That drop is shallower than the 10.9 percent drop that IDC reported for the wider PC market earlier this month. The iPod segment also continues to dry up at a steady clip, with just 4.57 million of the music players selling this quarter compared to 6.8 million a year ago. This is the continuation of a trend that began not long after the iPhone launched and has only accelerated in the last two years as smartphones have become more popular.

The iPad's sales drop was a bit more troubling, given that it's still one of Apple's big growth drivers. The company blamed the drop—14.6 million units, down from 17 million a year ago—on the third-generation iPad, which was enjoying strong sales from its first full quarter of availability at this time last year. Both the fourth-generation iPad and the iPad mini were introduced back in November of 2012. So while new tablets are widely expected later in the year, the current models are mid-cycle.

Apple's fiscal fourth quarter is expected to be slightly stronger than this one—Apple's guidance predicted revenue between $34 and $37 billion and margins that fall within the same 36 and 37 percent window as this quarter. Quite a few of Apple's marquee, high-end products—the Mac Pro, the Retina MacBook Pros, the flagship iPhone, and both iPads—should all be seeing refreshes before the end of the year, and we'd expect these products to boost Apple's numbers toward the end of the fourth quarter of 2013 and going into the first quarter of 2014.

For more on Apple's earnings, including its tax rate, cash hoard, and stock buyback, you can consult the company's press release. You can also listen to the call in full for the next two weeks by downloading it from iTunes.

62 Reader Comments

This is the reality of what can be expected for both Apple and Samsung going forward as they deal with declining (but still leading and healthy) profits as wealthy nations saturate with Smartphones and they face more pressure to deliver leading (but more economical) products to developing nations.

I have confidence both can maintain leading positions, but the days of extracting 100% percent plus profits are probably gone since lower cost competitors have relatively better share of such markets and likely to maintain that since there is a limit how far A & S can go without hurting their brands.

My iPhone 4S is old but still works fine, I can wait for the next generation. My wife's iPhone 5 is never far from her side as her bloody must have iPad goes neglected by her (but not our daughter).

I think we are a typical household. 2 phone users. 1 tablet user. Old MacBook Pros all around. Aside from the fact my gadget loving wife needs whatever hot new iPhone is available, the rest of that stuff gets replaced when it breaks or gets lost.

So what do you imagine as these great new features which will make the iPhone 6 a MUST have device, worth paying $650 for, even though one owns an iPhone5? 802.11ac is nice, but I don't see it as in this category. Health monitoring is nice, but that seems likely to be delivered via iWatch not iPhone. Fingerprint recognition (and/or augmented by facial recognition) is very nice, and will be the killer feature for a small (note small) group of people. Most will appreciate the point but figure "heck, let's wait till my phone is stolen, then I'll get the secure one".

I think well-executed new features or improvements can quite change the way you use a phone even if there's nothing revolutionary. Fingerprint recognition integrated with the touchscreen (as Apple patented recently) would be such a thing: Unlocking a phone by just using it is really useful. Or low-power always-on voice recognition as Motorola seems to come with now. Much better cameras (Nokia) will be a perfectly valid reason for many people to buy a new phone even if the old one still is "good enough". And so on.

So what do you imagine as these great new features which will make the iPhone 6 a MUST have device, worth paying $650 for, even though one owns an iPhone5? 802.11ac is nice, but I don't see it as in this category. Health monitoring is nice, but that seems likely to be delivered via iWatch not iPhone. Fingerprint recognition (and/or augmented by facial recognition) is very nice, and will be the killer feature for a small (note small) group of people. Most will appreciate the point but figure "heck, let's wait till my phone is stolen, then I'll get the secure one".

I think well-executed new features or improvements can quite change the way you use a phone even if there's nothing revolutionary. Fingerprint recognition integrated with the touchscreen (as Apple patented recently) would be such a thing: Unlocking a phone by just using it is really useful. Or low-power always-on voice recognition as Motorola seems to come with now. Much better cameras (Nokia) will be a perfectly valid reason for many people to buy a new phone even if the old one still is "good enough". And so on.

The trouble is that we pesky Brits call these things by different names. For anyone needing a dictionary, US Revenue is GB Turnover; US Net Income is GB Retained Profit (or GB Profit After Tax); cumulative total of top 3 lines is GB EBITDA; and cumulative total to US Interest Expense is GB Profit Before Tax (the most commonly cited number in the UK).

Apple does not need to make a cheap iPhone. If it's junk it will hurt the Apple brand. If it's good it will cannibalize sales of their flagship phone. Sure the lower price point might bring some new customers into the fold but the reality is a lot of them are already using discarded iPhones from upgraders. What would it take to make them switch?

Apple has never made a cheap consumer laptop or desktop. Their domain is high price, high quality, high margin and it has made them one of the most successful companies in US history.

The desire to fill every niche of the market comes from the usual corporate trap of growth by any means necessary. Apple should leave the unprofitable market segments for its competitors to fight over.

During the analyst question and answer session, more than one analyst attempted to draw information from Cook and Oppenheimer about a lower-cost iPhone (as well as other teased "new product categories"), but neither would share any new information.

Why do they bother?

This hasn't changed in over a decade of Apple conference calls. Most of these brilliant analysts simply don't have enough brainpower to ask interesting questions that would be answered.

Apple does not need to make a cheap iPhone. If it's junk it will hurt the Apple brand. If it's good it will cannibalize sales of their flagship phone. Sure the lower price point might bring some new customers into the fold but the reality is a lot of them are already using discarded iPhones from upgraders. What would it take to make them switch?

A cheap phone doesn't have to be junk and Apple has never concerned themselves with cannibalising sales among their own products. The iPad is killing their Mac lineup right now and Macs are much more profitable.

All it would take to "make them switch" is for them to think they can offer a compelling product.

Apple has never made a cheap consumer laptop or desktop. Their domain is high price, high quality, high margin and it has made them one of the most successful companies in US history.

High margin yes, but they've made plenty of cheap laptops and desktops. The plastic macbooks were cheap, the mac mini is cheap.

Right now the iPhone 4 and 4S are "cannibalising" iPhone 5 sales. But they still sell them, because Apple doesn't let that dictate their strategy. The 4 and 4S are both very good products, and it's profitable to sell them, so Apple is doing it. Simple as that.

The Foxconn number I should hope is a typo. As of 2011, they had 500,000 employees

You're right, sorry about that. The proper number is 1.25 million. But they have individual factories with almost 500,000 employees, and many factories spread all around the globe (this makes me wonder how many factory workers are not "employees", since the 1.25 million figure seems too small).

Anyway they're orders of magnitude bigger than Apple, which was the main point. Foxconn manufactures 40% of all consumer electronics sold.

The "Model-T" sales model potentially has greater margins, but as with Ford, Apple will be undercut as people decide they really want a more unique and custom phone, rather than the single model offered to them by the benevolent dictator.

People have been arguing this since the original iPhone was released, yet for six years, sales have been going up – all the way through to the present day where they just hit a quarterly record.

For that matter, people argued the same thing about the iPod (Apple will lose its lead as competitors undercut them with lower prices and more variety), and yet we're 12 years into that product and Apple still maintains 70% marketshare.

These supposed "tipping points" where Apple's one-size-fits-all philosophy suddenly backfires never actually happen, yet it gets argued every time they release a new product, even though all of their previous successes completely contradict it.

The Foxconn number I should hope is a typo. As of 2011, they had 500,000 employees

You're right, sorry about that. The proper number is 1.25 million. But they have individual factories with almost 500,000 employees, and many factories spread all around the globe (this makes me wonder how many factory workers are not "employees", since the 1.25 million figure seems too small).

Anyway they're orders of magnitude bigger than Apple, which was the main point. Foxconn manufactures 40% of all consumer electronics sold.

They have one factory with 500,000 employees, although a quick google shows that number to be quite hard to actually pin down. 1.2 million sounds about right for the company as a whole. Even with factories around the world, most production facilities (for just about any product) don't get above the thousands or tens-of-thousands of employees range. Considering 1.2 million puts Foxconn up in (or near) the top ten largest employers, I think it's probably in the right range. Even a few tens of thousands of workers miscounted here or there simply isn't enough to move the needle much.

Apple does not need to make a cheap iPhone. If it's junk it will hurt the Apple brand. If it's good it will cannibalize sales of their flagship phone. Sure the lower price point might bring some new customers into the fold but the reality is a lot of them are already using discarded iPhones from upgraders. What would it take to make them switch?

Apple has never made a cheap consumer laptop or desktop. Their domain is high price, high quality, high margin and it has made them one of the most successful companies in US history.

The desire to fill every niche of the market comes from the usual corporate trap of growth by any means necessary. Apple should leave the unprofitable market segments for its competitors to fight over.

Someone is going to cannibalize Apple's flagship brand. From their perspective, better they do it than someone else.

WIth Penryn, desktop machines became good enough, for a large enough fraction of users, that the game changed completely and, pretty much on a dime, the PC industry went from one where users upgraded every two or three years to one where users upgrade when the machine dies and no sooner.

It has happened, over and over, in the PC market. Hardware gets fast enough to run the software of the day, and people don't think about upgrades for a while. The newer, more intensive software comes out, and we start the PC upgrade cycle all over again. It's commonly because of newer versions of Windows being dog slow. But this time around, I'd keep an eye on the new video codecs, H.265/HEVC and VP9. Both will require significantly more performance than their predecessors, for both decoding and encoding, in exchange for less higher quality with smaller files and less bandwidth usage. When Netflix, Hulu, YouTube, and others start serving up videos in their formats, and people find the video stutters and pauses on their old machines, we'll likely be back to mass PC upgrades once again.

For that matter, people argued the same thing about the iPod (Apple will lose its lead as competitors undercut them with lower prices and more variety), and yet we're 12 years into that product and Apple still maintains 70% marketshare.

70% market share in a DEAD market. Apple released the iPhone because they saw that people didn't want to carry around an MP3 player, and feature phones could play MP3s just as well. That's what killed the iPod.

The Model-T was made for 20 years, I'm sure for the first 6 it looked like there was no end in sight, too. But Apple's margins getting thinner is a sure sign that the iPhone isn't as sought-after as it once was. The fact that Android hhas massively overtaken the iPhone is a good indication of the huge market Apple is missing out on. The market has grown by leaps and bounds, but Apple's sales only see tiny gains, while Android sales are through the roof. There's just no denying that Apple is missing-out on the MAJORITY of the market, even if they can do a few tricks to keep sales slightly rising and pretend it's sustainable.

For that matter, people argued the same thing about the iPod (Apple will lose its lead as competitors undercut them with lower prices and more variety), and yet we're 12 years into that product and Apple still maintains 70% marketshare.

70% market share in a DEAD market. Apple released the iPhone because they saw that people didn't want to carry around an MP3 player, and feature phones could play MP3s just as well. That's what killed the iPod.

What does it matter that the MP3 player market is dead now? The point is that the iPod was never marginalized by a wider variety of less expensive competing MP3 players, as was constantly predicted would happen for years on end. You're right; it was Apple's own iPhone that disrupted the iPod instead.

"Apple should leave the unprofitable market segments for its competitors to fight over. "

The problem is that the segments it is in are changing. The margins are falling. That is a critical sign. Apple is now going to have to start choosing, in its existing segments, between lower margins and lower volumes or lower market share.

So far it has managed to avoid the choices by finding new segments to enter. It will not execute well if it accepts the positioning needed to keep market share, which will be a quite different business model and supply and distribution chain.

But if it does not find another segment, and find it soon, and it had better be big and one that it can initially dominate, it will be entering the iceberg region. The share price is reflecting these concerns. It is still discounting a very optimistic future, but its getting more realistic in the last year or so. But unless they discover a new segment soon it has a lot further to fall.

For that matter, people argued the same thing about the iPod (Apple will lose its lead as competitors undercut them with lower prices and more variety), and yet we're 12 years into that product and Apple still maintains 70% marketshare.

70% market share in a DEAD market.

Apple still sells more iPods than all manufacturers combined sell Phablets - the undead market Apple is constantly told to enter.

For that matter, people argued the same thing about the iPod (Apple will lose its lead as competitors undercut them with lower prices and more variety), and yet we're 12 years into that product and Apple still maintains 70% marketshare.

70% market share in a DEAD market.

There are companies that would KILL for the profits Apple makes on iPods alone. Including many MP3 player manufacturers.

IPod sales were 2% of Apple's revenue this last quarter, that ain't chicken feed. Hell, I wouldn't be surprised if Apple's iPod profits alone were almost as much as Dell's entire profits last quarter. (Hard to say, since Apple doesn't break it out that way and I don't know what the profit margins are, but it would be close if we can assume profit margins of about 40%.)

In any case, for a dead market, iPod profits (never mind revenues) are most likely in the hundreds of millions of dollars -- nothing to sneeze at.

But if it does not find another segment, and find it soon, and it had better be big and one that it can initially dominate, it will be entering the iceberg region. The share price is reflecting these concerns. It is still discounting a very optimistic future, but its getting more realistic in the last year or so. But unless they discover a new segment soon it has a lot further to fall.

I don't get why only Apple is held to this standard where they have to constantly enter new market segments and dominate them in order to stay relevant. For most of its existence, Apple had one product – the Mac – and managed to run a healthy business (with the exception of the "lost years" of the mid-90s) for a very long time. They now have three additional products that are all far bigger individually than the Mac ever was (for instance, I think the iPad sold more units in its first year on the market than Macs in total since the founding of the company).

The market is maturing and growth is falling to less-insane levels, but that's to be expected. Doesn't meant at all that they're in trouble if they don't find something "new" to do.

Andrew Cunningham / Andrew has a B.A. in Classics from Kenyon College and has over five years of experience in IT. His work has appeared on Charge Shot!!! and AnandTech, and he records a weekly book podcast called Overdue.